Introduction
2019 has been quite a ride for global markets. The year started with a rallying S&P and confident markets which quickly transitioned into fear, uncertainty and doubt, as the Sino-American trade war took center stage and the yield curve inverted for the first time since 2008, summoning fears of an impending recession.
In that environment, cryptoassets had a mercurial H1 2019, coming off of a brutal bear market in 2018.
Emerging cryptoassets within the cluster outperformed the average in Q1, passing the baton to Bitcoin in Q2, which led the way with a 230% appreciation, bottom-to-top, from April to July 2019. At the time, there were strong indications that the pent up demand for capital flight from China found a suitable vehicle in Bitcoin, as global economic uncertainty rose [1]. However, this did not sustain for long, leading the overall asset class to deflate by 50% over the course of H2 2019.
Although Bitcoin failed to meet expectations set by the excitement garnered by 1H19’s run-up to $13k per BTC, the asset class overall is once again the best performing for the year, returning +90% beginning to end, whereas the NASDAQ returned +38%, the S&P +31% and REITs +27%.
Be that as it may, the sentiment among market participants - at present - is much bleaker than the absolute YoY performance implies, reminding us that biases are omnipresent in how sentiment manifests in markets. In this case, it is an anchoring bias, a recency bias and loss aversion in full effect [2].
As Bitcoin descended from July highs for most of 2H19, the trade war fears were dispelled and under the onlook of a dovish Fed, the Dow and the S&P both broke to new all-time highs.
Considering the developments on the ground within the world of cryptoassets, we are - quite frankly - dumbfounded by the weak sentiment.
While being cognizant and appreciative of the limitations of cryptoassets and the challenges that lie ahead, we cannot help but continue to be optimistic about the medium and long term prospects of the asset class.
2019: a year of quiet infrastructure development
Our thesis has always been that there are two forces that charge the adoption of cryptoassets; 1. top-down adoption by institutions and legacy finance, and 2. bottom-up adoption of Web 3.0 and Open Finance innovations and primitives by the general public.
2019 was a year of steady infrastructure development and deployment in both of these areas.
TOP DOWN
2019 saw a continuous stream of innovation in institutional infrastructure, with cornerstone products such as digital asset custody and derivatives being delivered and further developed from both legacy players such as Fidelity, ICE and the CME [3], as well as crypto native players such as Coinbase, BitGo and Binance [4]. These advances are bringing mature and trusted prime brokerage solutions closer to the cryptocurrency industry, and will enable the deployment of ever more complex strategies at scale, while simplifying the complexity at the base layer of this technology, head-on.
At the same time though, 2019 saw multiple rejections of applications for a Bitcoin ETF - and for good reason. The market is still fairly fragmented, small and immature for an ETF, with a prime example being the lack of a generally accepted and agreed upon true price of Bitcoin. Despite this, in December 2019 Charles Schwab reported that Grayscale’s Bitcoin Trust is the 4th most popular equity amongst Millennials in their customer base - more popular than Netflix or Berkshire Hathaway [5].
As progress in data pipelines is made and liquidity improves, the uncertainties around the asset class will become increasingly less, at which point we expect to see the development of products that will make Bitcoin’s inclusion into ISAs (Individual Savings Account) and IRAs (Individual Retirement Account), a matter of routine.
While we do not believe that this will become commonplace in 2020, we do believe we will see material progress in that direction, both in regulations, and in market structure/infrastructure.
Once that milestone is cleared, and the asset class has grown sufficiently to become even more generally accepted, the probability of it being included as an asset of pension funds and endowments increases dramatically. The most forward thinking of the largest allocators are already getting smart in and around the asset class, primarily via allocating to Venture Capital [7], while some have started dipping their toes in direct token purchases.
The last but perhaps most important piece of the puzzle for top down adoption is regulatory clarity - or, at present, lack thereof. Bitcoin’s Q2 ascent was accompanied by the announcement of Libra - Facebook’s blockchain-based stablecoin initiative, that would bring digital wallet infrastructure to Facebook’s massive user base.
Libra’s launch was soon put on hold by US lawmakers, with both Mark Zuckerberg and David Marcus (Libra CEO) having to undergo multiple rounds of hearings in front of the US Congress and Senate. The most important takeaway to come out of those hearings, was the lack of alignment among members of the House and Senate, which continues to spell uncertainty for entrepreneurs and managers in the space.
Meanwhile, in October, Xi Jinping publicly labeled blockchain an important strategic focus for China, causing a flurry of activity in the market [9].
Amongst the most notable events to follow, the Bundestag issued a decree enabling German banks to sell and custody crypto starting 2020, the ECB announcing a proof-of-concept for anonymous transactions using central bank backed digital currency, and more recently a draft bill entitled “Crypto-Currency Act of 2020” was introduced in the US House of Representatives.
Given the sense of urgency that China’s aggressive move seems to have instilled in its counterparts, we believe that 2020 is going to be a pivotal year for a much needed regulatory framework that will de-risk the emerging asset class.
BOTTOM-UP
Even in the face of structural uncertainty, in 2019 the builders have been hard at work and their labour is already bearing fruit - with Ethereum (#2 public blockchain and #1 smart contract platform by market capitalization) the clear leader in attracting developer interest. Ethereum has been a hotbed for developer activity, with Open Finance (or DeFi) use cases finding notable traction.
There are now stable value issuers (e.g. Maker DAO), loan facilities (e.g. Compound), market makers and exchanges (e.g. Uniswap, Kyber) and derivatives products (e.g. Synthetix) that are fairly well established, while we are seeing use cases in insurance (e.g. Nexus Mutual), interfaces (e.g. Zerion), and payments (e.g. xDai) emerge.
These protocols and applications live purely on-chain, are largely software operated and have processed multiple hundreds of millions of USD in loans, payments and collateral value in 2019 [10].
Over the course of 2019, Ethereum became a lot more expressive. There are now more frameworks, IDEs and mature blocks of value within Ethereum that can be used as references for new applications, enabling developers to deploy a wider array of features, faster than ever before.
Given the product/market fit that the category is showing, Ethereum’s lead in developer mindshare and maturity of tooling, but also being cognizant of the platform’s scaling and governance limitations , we believe this to be the space where most value will be created and captured in the next 2-3 years.
It is indicative that in an indexing exercise exploring 2019 returns, DeFi has been the standout performer, primarily driven by the mercurial H2 performance of Synthetix (SNX) - a 30x run. Additionally, the money and finance related indices have strongly outperformed all other clusters in 2019 - a clear indication of where product/market fit can be found at present and how much it matters to the market.
Some of the areas that we are excited by within the cluster, are synthetic asset solutions that will reduce collateral ratio requirements, allow for legacy assets (e.g. equities) to be printed on chain and transacted at a fraction of the cost of traditional brokerages, enablers of new forms of hedging risk for crypto native businesses (e.g. hashrate derivatives) and - well - new forms of leverage. After all, given the early stage we are currently in, speculation largely remains the main use case.
Concurrently, in 2019 we saw glimpses of the rise of domain specific chains. Different fee structures for platform resources and performance limitations and trade-offs across different chains create breeding grounds for fundamentally different applications (e.g. Flow).
As such, while Ethereum has found traction in use cases that are described by low friction and high transaction value, chains like EOS - and more recently WAX - are finding traction in high friction and low volume applications (e.g. games & gambling) [11].
While - in theory - Layer 2 solutions can allow for such applications to work on slower chains, it is hard to argue that these solutions will provide a more compelling alternative to chains that are purpose built to withstand heavier loads. Then again, whether or not the necessity for transaction speed will trump the value multiplier that a network effect can be, remains to be seen.
Most of the aforementioned platforms are still in their infancy and others are yet to launch, as is the case with the interoperability bridges that will allow value to frictionlessly traverse through different blockchain ecosystems (e.g. Cosmos).
We see the next two years as the time when these platforms will prove (or disprove) their viability and pave the way for fulfilling the Web 3.0 vision from 2021 onwards.
